I started my career in real estate in 2011 and have experienced a decade of low rates and increasing asset values. Success in multifamily investing was driven simply by being in the game. Well, the game has changed.

Today’s environment is unprecedented.  I’ve been spending an inordinate amount of time recently reading macro news, speaking with brokers, and underwriting deals.

We’ve quickly shifted from over-exuberance to fear and everyone I speak to in the multifamily space is preparing for “distress” and lining up capital for buying opportunities. While there has been a much-needed pricing reset, I don’t foresee any real distress or fire sale pricing.

In this post, I’m going to lay out my view on what’s driving opportunities (or lack thereof) and what may create select buying opportunities.

TLDR: There will be little to no distress and pricing will not come down nearly as much as many believe. Those waiting for opportunities will be disappointed and remain on the sidelines. Multifamily fundamentals remain strong, there’s historic amounts of capital chasing deals, and quality sponsors/lenders will work through rate-driven debt challenges creating win/win scenarios. There will be select forced sales and one-off distress (i.e. Veritas) that will steal the headlines and lead misguided skeptics to claim this is the first shoe to drop, but they will be wrong.

Before we dive into it, here are the things I believe to be true today which drive my thinking:

• The Fed got it wrong. They misguided the market, they waited too long to raise rates, and when they did, they raised rates too aggressively.   
• Inflation is gone (based on annualized figures) and additional rate increases aren’t needed.  The Fed will continue to raise rates, but at a slower pace.
• We have a labor shortage, and the solution is not to push the economy into a recession to lose jobs.  
• The banks are flush with cash, but banks aren’t lending today. When money flows, cap rates will decline/stabilize. Cap rates are driven by the flow of funds, not interest rates directly. When rates rose so quickly, lending froze.
• Investors are flush with cash and waiting to pounce on good opportunities.
• The economy is doing fairly well (despite what the news may make you think); the consumer and businesses are in good shape.
• A recession, if it comes at all, will be short-term (6-12 months) while real estate investments are generally long-term (5-10+ years).
• Multifamily fundamentals remain strong and there is virtually no operational distress. Demand will rebound this year after a very slow 2H 2022.
• The slow 2H 2022 was driven by low consumer confidence due to recession fears, not job losses.
• The 10-year treasury will hover in the mid-3% range. The short-term rates are too high and the inverted yield curve is misleading.
• Rates will come back down over the next 12-24 months, so if you can stick it out for a while you’ll be fine.  
• The doomsday crowd is basking in the negative sentiment, yet the same crowd predicted a recession in 2020 and 2021. Pessimists don’t make money in real estate.

So where does that leave us today and what opportunities may we see in 2023?

Multifamily real estate values are down somewhere between 10%-20% below the over-inflated peak.

In today’s market, there is little to no operational distress, renter demand is rebounding, and the bid/ask spread remains wide. The only real sellers today are those who are forced to sell due to loan maturities and unhedged bridge loans, and those who opt to sell because they bought at a great basis, can offer attractive assumable debt, and can take advantage of the historic amount of cash chasing deals in an environment with limited deal flow.

See the chart below from Yardi which quantifies the sources of potential deal flow:

The most likely set of buying opportunities will be deals acquired in 2020/21 with maturing short-term bridge debt. Many of these deals were trading in the 3% – 3.5% cap rate range based on the belief that interest rates would stay low, rents would continue to grow at an outsized rate, and expenses would remain predictable. Owners of these deals are contending with several issues:  

• Interest rates spiked with SOFR going from 0.05% at the end of 2021 to 4.30% today (1/26/23).
• Rent growth flattened or turned negative as consumer confidence weakened and new deliveries picked up.
• Expenses spiked, notably in line items such as insurance, payroll, and R&M.

Select sponsors (who aren’t well-capitalized) hit by a confluence of issues have a few options; 1) they can take on expensive pref equity, 2) do a capital call, or 3) sell.

Let’s take a simple example. If you bought a value-add multifamily deal at a 3.5% cap, increased NOI by 50% over the past 2-3 years, and used 70% LTC bridge financing (without a cap), you’re barely covering debt service today and cannot take out your bridge loan with fixed-rate financing given today’s pricing.

The increase in NOI has led to stabilized yield-on-cost of 4.9%. In this scenario, assuming little value-add upside remaining, the path of least resistance is to sell. There’s no shortage of buyers sitting on loads of capital, ready to buy. These sellers will under-perform, but still return 100%+ of investor capital.

The next set of opportunities will be construction loans maturing in 2023. The biggest risk of development, in my opinion, is being forced to sell into an uncertain environment (this is why we only focus on OZ deals). However, developers with construction loans maturing in 2023 likely bought the land and secured a GMP in 2018-20, when prices were attractive and rents were 25%+ lower.

These developers will do just fine, although they won’t hit the home-run they expected I late 2021.  

The last set of deal flow today will come from owners who bought deals with fixed-rate financing in 2017-2020. Many of these loans have 5-7 years of term remaining with rates in the 3’s. The ability to offer assumable below-market debt, even at low leverage, is attractive to long-term focused buyers. This subset of sellers can test the market and will sell if they get their number. If not, they’re happy to continue to hold.

I recently listened to Peter Linneman on the Walker Webcast and his sentiment was simple; “stay alive until mid-2024.” Hunker down if you need to; cut distributions, pause voluntary capex projects, and focus on maximizing net cash flow. Rates will come back down and disciplined owners will be just fine.

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No one knows what’s going to happen over the next 6-18 months. It’s impossible to time the market and not worth trying. Stick to your niche, be relentless in your sourcing efforts, and go after deals aggressively when they fit your buying criteria. We know the bid/ask spread is wide and transactions will be slow, but as noted above, there will be some forced selling due to loan maturities into an environment where the capital markets remain frozen.

If you’re going to sit back and wait for opportunities to come to you, guess what, they’re not coming.